Stock Analysis the Home Depot

Stock Analysis The Home Depot was founded, according to the company website, in 1978 in Atlanta, Georgia and is currently operating more than 1,900 stores such as The Home Depot, EXPO Design Center, The Home Depot Supply and other subsidiary companies across North America.

The company boasts being the world's largest home improvement retailer and defines its business as addressed to "do-it-yourself, do-it-for me and professional customers who serve the home improvement construction and building maintenance market segments." The company feels it has "revolutionized the home improvement industry by offering an unparalleled selection of products and services under one roof." The statement is not far from the truth, since 40,000 different kinds of building materials and lawn and garden products are sold in HD stores today.

The company's services include free in-store clinics for honing home improvement skills, design and decorating consultation, truck and tool rental, home delivery and others. Some subsidiaries specialize in flooring, lighting, plumbing and landscape supply. Design professionals are covered by the EXPO Design Centers. The Home Depot operates in 50 U.S. states and in the District of Columbia, Puerto Rico, 10 Canadian provinces and Mexico. In addition, two sourcing offices were recently opened in China. Since it is such a large company, Home Depot cannot escape the attention of the press.

DSN Retailing Today reports that Home Depot has been subpoenaed by federal prosecutors in Los Angeles. The prosecutors are looking for documents and information relating to the company's handling, storage and disposal of hazardous waste. The company stated in a Securities and Exchange Commission filing that it has received a grand jury subpoena from the United States Attorney's Office in Los Angeles, California.

The Home Depot has also stated in the SEC filing that "California state and local government authorities are also investigating this matter, and the company is cooperating fully with the respective authorities," a phrase the company hopes will make investors relax. Ten days later, on 11 August 2005, the company announced that it has completed its rollout of LG home appliances. According to Home Channel News, "Home Depot, the world's largest home improvement retailer [shall sell] laundry systems, refrigerators, dishwashers, air conditioners, over-the-range microhoods and countertop microwave ovens.

The distribution system is not yet fully prepared, since the articles mentions the fact that, although appliances are currently available in more than 1,700 Home Depot stores nationwide, they are not yet available at Expo Design Center locations and online at homedepot.com. However, the company announced that the problem would be corrected later this month.

The report also cites John Costello, executive vp-merchandising and marketing for Home Depot., who says that "We're pleased to complete the rollout of innovative LG home appliances, which complement our rich portfolio of top home appliance brands...LG has a proven track record of incorporating innovative technologies with leading-edge design into its products, and our partnership with the company allows us to deliver these innovations to our customers." In addition, Teddy Hwang, president of digital appliances, LG Electronics U.S.A., said that "Our presence in The Home Depot stores is sure to accelerate the success we've experienced thus far in the United States.

This collaboration will provide exposure of our products to a customer base that presents a major growth opportunity for us." As far as profitability is concerned, the Net Margin recorded by HD amounts to 6.91%, with an average Asset Turnover of 1.87. The Return on Assets amounts to 12.89%, which is less that the figure recorded last year (13.36%). Home Depot's operating margin has expanded during the last three years mainly due to gross margin improvements, triggered by a centralization of its product purchases.

The Return on Equity goes as high as 22.26%, higher than in any of the previous ten years. In Lowe's case, the Net Margin is only 6.13%, the average Asset Turnover is 1.73, while the Return on Assets amounts to 10.58%. The Return on equity figure is slightly smaller than the one recorded by Home Depot, i.e. 20.55% Over the past 10 years, Lowe's sales and earnings have grown at average rates of 20% and 26%, respectively. The company's financial results have been deemed as being "among the best in retailing" by analysts.

The growth is attributed to a combination of aggressive new-store openings, consistent midsingle-digit growth in comparable-store sales (sales at stores open at least a year), and expanding profit margins (Morningstar Analyst Report). Lowe's is however still on the move. Major investments in installed sales, sales to contractors and special orders are intended to continue to drive sales growth and profit margin expansion. Asset utilization ratios for the two companies under analysis are comparable.

The Cash Conversion Cycle figure is 30.7 in the case of Home Depot, while Lowe's records more than 41, a number HD has passed since 2002. The figures for Receivables Turnover are 42.9, in HD's case and 380.8 in Lowe's case, which is surprisingly high. The Inventory Turnovers are similar: 4.6 for HD and 4 for Lowe. The same goes for Fixed Asset Turnover - 3.4 and 2.8, while the total asset turnover is very similar - 1.9 for HD and 1.7 for Lowe. Both companies have good efficiency ratios, close to the industry standards.

Liquidity ratios are very similar in the case of Home Depot and Lowe. The Current Ratio is practically identical - 1.22 for Home Depot and 1.19 for Low. The Quick Ratios have low values - 0.36 for Home Depot and 0.18 for Lowe. Although the Home Depot's quick ratio is double the one recorded by Lowe, the fact the values are quite low makes the difference less significant. The debt utilization chapter proves interesting when comparing the two companies.

According to Morningstar analysts, Home Depot currently has $2.1 billion in long-term debt and $3.0 billion in cash and cash equivalents. The company's strong cash position provides it with the financial flexibility to opportunistically pursue acquisitions. The financial leverage of the company amounts to 1.76, while Lowe records a level of 1.91. Lowe's has $3.7 billion in debt and $1.2 billion in cash and short-term investments. The company is currently generating positive free cash flow, although it has for years financed its aggressive store expansion through new stock and debt issuance.

The debt/equity ratio is 6 times higher for Lowe than it is for Home Depot. This indicates that the management of the latter has focused on financing its activity mainly with own funds, while the former founded its financial policy on the issuance of debt instruments. The Home Depot has extremely low Debt/Equity ratios since 2000, when it has recorded a 0.06 level, while Lowe has always had large amounts of debt compared to its equity.

The Return on Equity ratio is calculated (by using the DuPont formula) in the following way. ROE = Net Profit Margin x Asset Turnover x Equity Multiplier (or Financial Leverage) In Home Depot's case, the formula is ROE = 6.91 x 1.9 x 1.76 = 23.107% In Lowe's case, the formula is ROE = 6.13 x 1.7 x 1.908 = 19.88% Home Depot investors have an advantage based on superior Net Profit Margin and Asset Turnover. The influence of the Net Profit Margin is the most significant, followed by that of the Asset Turnover.

Combined leverage is the product of operating leverage and financial leverage. The total leverage measures the percentage change in EPS that results from a change in one percent in output and it also assists in measuring the firm's total risk. In our case, the operating leverage of the Home Depot has been estimated at 1.07. Lowe is nearby, with 1.05. The Financial leverage for the two companies is 1.76 and 1.91 respectively. Consequently, the total leverage amounts to 1.883 for the Home Depot and 2.005 for Lowe. The differences are yet again not very important.

The cost of capital is the discount rate that makes the quantity of funds required for the investment project equal to the quantity of funds available at that particular cost of capital. As far as the cost of capital is concerned, Morningstar analysts report that Lowe's has begun to generate free cash flow and return value to shareholders through dividends and share repurchases. Lowe's 10.2% operating margin in 2004, although impressive, is behind.